Moody’s places Israel’s ratings on review for possible upgrade

Moody’s has placed Israel‘s A2 government bond ratings and the A2 country ceiling for foreign currency bank deposits on review for possible upgrade. The ratings have carried a positive outlook since May 2006. All other sovereign ratings are affirmed, including the Aa1 country ceiling for foreign currency debt.

The review for upgrade reflects both the resilience of the Israeli economy in response to repeated economic and political shocks and the fiscal consolidation of the past several years. Underlying the country’s rating is a history of financial and political support from the United States and the Jewish diaspora.

Moody’s review will primarily focus on the continued ability of the government to stay the course on debt reduction notwithstanding a fractious domestic and regional political environment and the ever-more challenging global credit climate.

“Its ability to absorb economic and political shocks without fundamentally subverting its prudent fiscal strategy nor undermining its economic vibrancy distinguishes Israel favorably relative to an emerging market,” according to Kristin Lindow, Moody’s lead sovereign analyst for Israel.

Lindow observed that Israel‘s high per capita income, its competitive high-tech and industrial sectors, and strong government effectiveness are more akin to an advanced developed country. Moody’s believes that advanced economies with strong institutional foundations and deep capital markets can better manage relatively large levels of government debt and are generally less volatile in terms of economic performance and policy.

But Lindow stressed that Israel‘s policy track record itself tells a compelling story about the country’s ability to withstand shocks and its payment capacity. Aside from a large government debt, explicit credit challenges include a low labor force participation rate and persistently high inflation.

“Until a little more than a decade ago, indexation sustained stubbornly high inflation that substantially raised the servicing costs of the government’s large domestic debt,” said Lindow. “A successful disinflation program, reinforced by a robust monetary policy framework and, more recently, fiscal orthodoxy has significantly reduced the debt and debt servicing burdens. Other structural reforms have brought down unemployment while raising labor participation.”

Fiscal discipline has been sustained in the face of economic and political pressures, said Lindow, including heightened military spending during and after the Second Lebanon War in 2006. She said that this track record underscores Israel‘s strong commitment to lowering the large public debt.

In contrast to the large, expensive domestic debt, Moody’s said that Israel‘s external debt and debt service is very manageable. About 70% of the government’s external debt is sourced from US loan guarantees or State of Israel Bonds at favorable costs of funding. State of Israel Bonds are sold mainly to Jewish communities outside of Israel, a group with deep and ready pockets to finance the Jewish state, especially during times of domestic or regional conflict. “These ample sources of liquidity are key credit strengths underlying Israel‘s high credit rating,” said Lindow.

Lindow pointed to Israel‘s precarious security environment and the very poor outlook for the resumption of a peace process with the Palestinians as another critical credit challenge.

“Ongoing regional and domestic conflict continues to complicate policymaking, contributes to outsized budgetary defense expenditures and also is an obstacle to increased investment and stronger growth,” cautioned Moody’s. “These factors are likely to constrain Israel‘s rating from reaching substantially higher rating levels.”

Lindow said that in spite of the substantial economic costs extracted by the political conflicts, Israel‘s high-tech sector is boosting GDP growth and government revenues. Though below potential, Israel‘s economic growth has been steady and quite strong.

“Although Israel is not a commodity-producing country, it has posted consistent current account surpluses in recent years, and the country is already a large net external creditor,” said Lindow. “These are key ingredients that help to insulate Israel‘s external sector from adverse global financial conditions.”